Private Enterprise
Behind the curtain:
What mid-sized private companies need to know
about what drives Private-Equity investments
Deloitte’s Commitment
to Private Enterprise
Deloitte has a large group of professionals committed to
serving the unique needs of growing private enterprise and
small- to mid-cap public clients who collectively represent
about half of our business. We deliver value through our
ability to draw on diverse industry, domestic and global
experiences and tailor our advice and services in a manner
that is relevant to our client’s industry, size, ownership and
other special circumstances.
Private Enterprise
Executive Summary
While CEOs and senior management of mid-sized private
companies attracting Private-Equity investment have the
potential to be richly rewarded for successful performance,
their tenure can be brief unless they continue to grow the
business and meet their targets. CEOs of mid-sized private
companies considering this financing option need to pursue
Private-Equity investment with a clear-eyed, honest appraisal
of both the risks and rewards it entails.
These are among the key findings of a survey of 269 senior
Private-Equity executives conducted by Deloitte and Touche
USA LLP. The purpose of the survey was to provide a snapshot
of current Private-Equity practices and their impact on the
owners of mid-sized private companies contemplating
Private-Equity investments.
Key Findings
• High pricing puts a premium on growth prospects.
With the competition for investment in attractive mid-sized
companies driving prices higher, a company’s growth outlook
was considered the most important factor in the investment
decision, rated much higher than current profitability.
• Quality of senior management team, not just the CEO,
is critical. The quality of the senior management team
was one of the most important factors Private-Equity firms
consider before making an investment in mid-sized private
companies. In contrast, the ability of the individual CEO or
President was one of the least important factors.
• Substantial incentives offered for success. Private-Equity
executives said their firms set aside a significant portion
of equity of a mid-sized company as an incentive for the
management team to achieve business goals—with 47% of
Private-Equity executives saying they set aside 5% to 10% of
equity, 34% setting aside 10% to 15% of equity, and 12%
setting aside 15% of equity or more. Only 7% of executives
said that they provide less than 5% in equity or provide no
equity incentives at all.
• Hit targets or management changes will be made. Senior
management of mid-sized private companies seeking PrivateEquity investment should realize that their tenure may be short
if they fail to meet business objectives. Roughly one-third of
Private-Equity executives said they had changed management
at more than 40% of their mid-sized portfolio companies,
usually due to targets not being met. Furthermore, when their
investments in mid-sized companies have failed to meet the
target internal rate of return, most Private-Equity executives
have blamed the poor management performance.
• Exit transactions can come quickly. CEOs of mid-sized
companies should not plan on an extended holding period.
Private-Equity executives said the mid-sized companies in
their portfolios were held on average for just four years,
with one-third citing even shorter holding periods. When
it comes to exit transactions, Private-Equity executives said
that a sale to a strategic buyer was the most common
type of transaction for the mid-sized companies in their
portfolios. While sales of Private-Equity portfolio companies
to strategic buyers will continue to be important, our
experience in the marketplace indicates that sales to other
Private-Equity firms will continue to increase.
Private Enterprise
Introduction
What do owners and executives at mid-sized private companies
need to know to successfully attract Private-Equity investment in
their business and share in the rewards of such a transaction in
today’s market?
To answer this question, Deloitte and Touche USA LLP
conducted a survey of 269 senior executives of Private-Equity
firms regarding the key factors they consider when investing
in mid-sized private companies. The survey provides insight
into the private-equity decision-making process and offers a
snapshot of current practices and issues affecting Private-Equity
investment in mid-sized private companies.
Private-Equity investment has become increasingly attractive to
mid-sized companies—those with annual revenues less than $1
billion—both as a source of capital and for the strategic advice
the fund managers provide to the companies they finance.
Industry experts estimate there are roughly 2,700 private-equity
firms around the globe, and the pool of capital allocated to
this asset class continues to grow. Fundraising in 2005 broke all
previous records, with $170 billion raised by 400 Private-Equity
groups alone, far higher than the $42 billion raised in 2004.1
Private-Equity funds could raise up to $300 billion in 2006,
if a healthy economy and low borrowing costs continue.2
Despite the well-spring of both the number funds and their
total assets, securing Private-Equity investment is challenging.
Leaders of mid-sized private companies need to understand the
key factors driving Private-Equity investment in their segment
and what such investment can entail for their companies…
Our findings revealed several key areas that leaders of
private mid-sized companies need to consider when seeking
Private-Equity investment:
• What Private-Equity firms look for when considering and
finalizing an investment;
• The role that the Private-Equity firm will play in the company
after the investment;
• The targeted returns expected by Private-Equity investors and
the implications on management;
• Exit scenarios: life after the investment.
Life Sciences/health care and Energy
Industries Expected to Lead the Pack
In which industries are mid-sized private companies
likely to see the most Private-Equity investment over
the next 12 months?
Private-Equity executives surveyed put the life sciences/
health care and the energy industries at the top of the list,
with 54% predicting that each of those industries would be
either first or second in Private-Equity activity. (See Exhibit 1.)
The technology/media/ telecommunications (TMT) industry
came in third with 37% of executives rating it number one
or number two as a target for Private-Equity investment in
mid-sized private companies. A likely explanation for the
high ranking of these industries is the emphasis placed by
Private-Equity firms on a strong growth outlook when they
are considering an investment.
&YIJCJU*OEVTUSJFT&YQFDUFEUPIBWF.PTU1SJWBUF
&RVJUZ*OWFTUNFOUTPWFS/FYU.POUIT
1FSDFOUPG&YFDVUJWFT3BOLJOH*OEVTUSZ/VNCFSPS
-JGF4DJFODFT)FBMUIDBSF
'JOBODJBM4FSWJDFT
&OFSHZ
3FUBJM
5.5
"WJBUJPO5SBOTQPSUBUJPO
.BOVGBDUVSJOHo$POT
5PVSJTN
.BOVGBDUVSJOHo0UIFS
Private Enterprise
What are Private-Equity Firms Looking for?
Strong growth prospects top the list. This should not be
surprising, given the high prices that the most attractive
deals command today.
But the Private-Equity executives surveyed said they are also
focusing intensely on the quality of the senior management
team as a whole when they consider and finalize an
investment. Perhaps the most surprising result was that the
quality of the CEO/President was the least important factor.
Private-Equity executives are looking for deep management
talent, rather than simply betting on the vision of a single
person. Other factors, such as profitability and barriers to
entry are important, but clearly are secondary.
Strong Growth Outlook Key
When Private-Equity firms decide whether to explore an
investment, strong growth prospects are the most important
factors. Eighty-two percent of the Private-Equity executives
surveyed said it was one of their top three factors, with 32%
rating it the most important consideration. (See Exhibit 2.)
Compare this statistic with the much lower emphasis placed
on profitability or competition when initially considering
an investment. Only 19% of the Private-Equity executives
surveyed cited profitability as the most important factor when
considering an investment, while 7% rated the likelihood of
new competitors as their top consideration.
&YIJCJU.PTU*NQPSUBOU"UUSJCVUFT8IFO$POTJEFSJOH
BO*OWFTUNFOUJOB.JE4J[FE1SJWBUF$PNQBOZ
5PUBM
(SPXUIQSPTQFDUT
2VBMJUZPGTFOJPS
NBOBHFNFOUUFBN
1SPmUBCJMJUZ
%JGmDVMUZGPSOFX
DPNQFUJUPSTUP
FOUFSUIFNBSLFU
2VBMJUZPG
$&01SFTJEFOU
The emphasis on growth outlook is a reflection of the
paradigm shift that has taken place in Private-Equity. In the
past, Private-Equity firms investing in mid-sized companies
were most interested in identifying businesses with strong,
stable earnings that were under-leveraged. In recent years,
however, intensified competition among Private-Equity firms
for the best companies has driven prices higher. While in the
past, Private-Equity firms would rarely pay more than seven
times EBITDA to acquire a mid-sized private company,
pricing now can be higher. Private-Equity firms must
target mid-sized companies with the growth potential to
support today’s higher prices.
When it came to their decisions not to submit an indication
of interest in a mid-sized private company, however, an
overwhelming 90% percent of executives said it was almost
always or frequently due to a poor outlook for growth and
profitability. (See Exhibit 3.) In addition, roughly three-quarters
of Private-Equity executives indicated said that a lack of growth
and profitability were often the reason they did not complete a
deal. (See Exhibit 4.)
Management Team Overall
More Important than CEO
A skilled and deep senior management team emerged as a
second critical factor in attracting Private-Equity investment—far
more important than the quality of the individual CEO/President.
More than 80% of the Private-Equity executives considered the
quality of the senior management team among their top three
factors when considering an investment, roughly equal to the
importance attached to growth prospects.
The relatively low importance placed on the quality of the
CEO/President, which was ranked last in importance, may be
related to the emphasis on growth. Companies that rely on the
ability, vision, or relationships of one individual often cannot
achieve significant growth. Private-Equity firms want to invest
in a business, not a solo act.
The quality of the mid-sized private company’s senior
management team remains an important factor throughout the
deal-making process. More than half the executives surveyed
stated that doubts about the quality of the senior management
team almost always or frequently resulted in their decision not to
submit an indication of interest or complete an investment.
3BOLFE
3BOLFE
3BOLFE
/PUF5PUBMQFSDFOUBHFTNBZEJGGFSGSPNSBOLJOHQFSDFOUBHFTEVFUPSPVOEJOH
Private Enterprise
Pricing and Ability to Achieve
Business Plan, Lead List of Other Hurdles
&YIJCJU3FBTPOT8IFOOPU$PNQMFUJOHBOJOWFTUNFOUJOB.JE4J[FE1SJWBUF$PNQBOZ
Competition for good deals is ferocious, and is resulting in
higher pricing. Seventy-three percent of executives said they
will pass on an investment opportunity in the initial evaluation
process early if they expected the company to command a
high transaction value and in turn lower their chances of
successfully achieving their targeted returns.
The achievability of the business plan also ranked high.
Roughly two-thirds of survey respondents said concerns about
whether the business plan was realistic had frequently led them
not to submit an indication of interest for mid-sized private
companies. A similar percentage said that this issue had often
prevented them from closing a planned investment.
Reasons when not Submitting an Indication of
Interest in a Mid-sized Private Company
&YIJCJU3FBTPOTXIFOOPU4VCNJUUJOHBO
*OEJDBUJPOPG*OUFSFTUJOB.JE4J[FE1SJWBUF$PNQBOZ
5PUBM
0VUMPPLGPSHSPXUI
BOEQSPmUBCJMJUZ
"DIJFWBCJMJUZPG
UIFCVTJOFTTQMBO
1SJDJOHUPPIJHI
2VBMJUZPGTFOJPS
NBOBHFNFOUUFBN
2VBMJUZPG$&0
1SFTJEFOU
-JLFMJIPPEPG
OFXDPNQFUJUPST
-BDLPGFYJU
PQQPSUVOJUJFT
#FUUFSRVBMJUZ
EFBMTBWBJMBCMF
5BYBOE
BDDPVOUJOHJTTVFT
&UIJDBMDPODFSOT
"MNPTU"MXBZT
'SFRVFOUMZ
5PUBM
0VUMPPLGPSHSPXUI
BOEQSPmUBCJMJUZ
1SJDJOHUPPIJHI
2VBMJUZPGTFOJPS
NBOBHFNFOUUFBN
2VBMJUZPG$&0
1SFTJEFOU
-BDLPGFYJU
PQQPSUVOJUJFT
#FUUFSRVBMJUZ
EFBMTBWBJMBCMF
5BYBOE
BDDPVOUJOHJTTVFT
"MNPTU"MXBZT
'SFRVFOUMZ
"DIJFWBCJMJUZPG
UIFCVTJOFTTQMBO
-JLFMJIPPEPG
OFXDPNQFUJUPST
Transferring Control
What role should mid-sized private companies expect their
Private-Equity partner to take in their business in addition to
providing capital?
Companies often relinquish a controlling interest to a
Private-Equity firm as part of the transaction. In return,
the targeted company will be able to leverage the industry
knowledge and strategic advice from their investor as well
as strong governance from a board of directors that has a
vested interest in the company’s success.
Private Enterprise
Size of Equity Ownership
Position Varies Widely
Although mid-sized private companies can expect to transfer
a considerable degree of control to the Private-Equity firm as
part of the deal, the percentage of ownership can vary widely.
The Private-Equity executives surveyed reported typical equity
ownership percentages in mid-sized companies ranging from
less than 25% to greater than 75%.
Surprisingly, while slightly more than half the executives
reported that they typically require a controlling interest
of 50% or more, a full 47% of Private-Equity executives
indicated that they usually acquire a minority interest in their
mid-sized private company targets. In other words, there
can be more flexibility in the structure of a Private-Equity
investment than owners of mid-sized companies may realize;
not every Private-Equity investment involves the purchase of
more than half the equity.
Executives at Private-Equity firms with large funds said they
were more likely to take a substantial ownership position
than those associated with smaller funds. One-third of the
executives at firms whose most recent fund was greater than
$100 million said they typically took equity positions of 75%
or more. In contrast, only 18% of executives from firms that
had most recently raised smaller funds said they typically took
equity positions that large.
Management of mid-sized private companies can also expect
the Private-Equity investor to assume majority representation on
the company’s board of directors. On an average, Private-Equity
executives reported that post-transaction, representatives of
the investing firm held 41% of the board seats. The company’s
management and outside directors each typically accounted for
29% of board membership. (See Exhibit 5.)
&YIJCJU1FSDFOUBHFPG.FNCFSTPG#PBSETPG%JSFDUPSTGPS
5ZQJDBM.JE4J[FE$PNQBOZJO1PSUGPMJP
"WFSBHF1FSDFOUBHFPG#PBSE.FNCFST
3FQSFTFOUBUJWFTPGQSJWBUFFRVJUZmSN
$PNQBOZNBOBHFNFOU
0VUTJEFEJSFDUPST
Meeting Expectations
Competing for investment in their funds with other asset
classes, Private-Equity firms face continued pressure to
outperform less risky alternatives on a risk-adjusted basis.
As a result, Private-Equity firms set aggressive targets for their
internal rates of return. They are willing to offer significant
rewards to senior company executives when targets are met
and to change management when targets are not met.
More than half of the Private-Equity executives surveyed said
they targeted an internal rate of return in excess of 25% when
investing in mid-sized private companies, with 28% of those
firms looking for returns greater than 30%. (See Exhibit 6)
Firms with smaller funds were more likely to set higher targets.
Thirty-eight percent of surveyed executives from firms whose
most recent fund was less than $100 million said they targeted
returns of 30% or more, compared with 25% of surveyed
executives from firms whose most recent fund was $100
million or more.
Private Enterprise
Operational Improvements
Key to Increased Value
Private-Equity deals used to be primarily about financial
engineering. But now Private-Equity firms have to earn their
returns the old fashioned way—by improving the operations of
the companies in which they invest.
Sixty-five percent of Private-Equity executives reported that
when they invested in a mid-sized private company, most
of the increased value typically came from operational
improvements rather than financial engineering.
A variety of Private-Equity models are currently being pursued.
While firms used to rely simply on financial engineering to
generate value, now there needs to be more. Private-Equity
firms typically add industry experts to the management team in
a variety of roles. Private-Equity groups seek to add horsepower
to the business they invest in, for example, by supplying
consultants or a new CFO, CEO, and board members. In each
situation, the Private-Equity group is seeking to add expertise
to refine the company’s strategy, pursue growth opportunities
more effectively, or improve profitability by reducing costs and
increasing efficiency.
While Private-Equity investors often “nurture” companies to more
healthy and productive market positions, management changes
are not uncommon when targets are not met. Thirty-five percent
of executives said management had changed in more than 40%
of their mid-sized portfolio companies.
But changes in management can result from subjective as well
as objective measures. Private-Equity investors said they will
change company management if they have concerns about
the quality and ability of the company’s management and
leadership, even more often than a failure to meet targets.
Concerns about management’s abilities was the factor cited
most frequently, with 72% of executives saying it was almost
always or frequently the reason for a change in management.
(See Exhibit 7.) Concerns about the quality of the company’s
leadership followed closely, cited by 69% of executives as a
reason for a management change.
More objective measures were also important, with a failure to
meet targets cited by 61% of executives as a frequent reason
for changing management after an investment.
&YIJCJU5ZQJDBM*OUFSOBM3BUFPG3FUVSOXIFO*OWFTUJOHJOB.JE4J[FE1SJWBUF$PNQBOZ
High-Performing Managers Amply Rewarded
Private-Equity executives highlighted the importance of a
high-quality management team during the investment deal
process, and the internal rates of return they set help explain
why. Most importantly, they are willing to provide healthy
incentives to achieve their objectives.
-FTTUIBO
oø
Almost half of the executives (47%) reported that their
firms set aside 5% to 10% of equity as incentive for the
management team to achieve their business objectives, with
another 34% setting aside 10% to 15% of the equity. A few
executives (12%) said their firms set aside 15% or more. Only
7% of executives said that they provide less than 5% in equity
or provide no equity incentives at all.
If the targeted returns are not met, however, Private-Equity
executives often point to poor management performance as
the cause. Fifty-nine percent of the Private-Equity executives
surveyed said that over the past three years, when the targeted
internal rate of return was not achieved, the reason was almost
always or frequently due to poor management performance.
However, more than half the executives also acknowledged
that the overall industry environment was also a common
reason for failing to achieve targets.
oø
o
oø
oø
o
-FTTUIBO
Private Enterprise
&YIJCJU'BDUPSTXIFO$IBOHJOH.BOBHFNFOUJOB.JE4J[FE1PSUGPMJP$PNQBOZ
1FSDFOUPG&YFDVUJWFT4BZJOH'BDUPSJT"MNPTU"MXBZTPS'SFRVFOUMZB3FBTPO
When asked what types of exit transactions their firm had used
over the past three years for the mid-sized private companies
in their portfolios, executives said that, on average, 49% of
exit transactions had been sales to strategic buyers, while onequarter had been to another Private-Equity firm. (See Exhibit 8.)
Recapitalization accounted for only 19% of the exit transactions.
Private-Equity groups consistently assess the likely exit paths
prior to making an investment. In today’s market, the number
of secondary buyouts (i.e., selling a company to another
Private-Equity group) is on the rise. We expect this trend to
continue as the combined demand from both strategic and
Private-Equity buyers outstrips the supply of attractive middlemarket companies available for investment.
&YIJCJU5ZQFTPG&YJU5SBOTBDUJPOTGPS.JE4J[FE1SJWBUF
$PNQBOJFTJO1PSUGPMJPPWFS-BTU5ISFF:FBST
"WFSBHF1FSDFOUBHFPG&YJU5SBOTBDUJPOT
$PODFSOTBCPVURVBMJUZPGNBOBHFNFOUBCJMJUZ
$PODFSOTBCPVURVBMJUZPGMFBEFSTIJQ
'BJMVSFUPNFFUUBSHFUT
1PPSDIFNJTUSZJODPNQBUJCMFDVMUVSFPSWBMVFT
&UIJDBMDPODFSOT
Exit Scenarios
How long will a Private-Equity firm hold a middle market
company in its portfolio? What type of transaction will they
use to exit their investments?
Private-Equity executives said that mid-sized private companies
were typically held in their portfolios for 4.3 years on average,
while roughly one-third said companies were held for less than
four years. In our experience, many Private-Equity investments
appear to be exited more quickly than in the past. PrivateEquity investors are simply weighing the potential benefits from
continuing to hold a company in their portfolios—growing it,
improving the cost structure, and paying down debt—versus
capitalizing on other investments. When the bulk of the heavy
lifting in adding value has been accomplished, which can often
be accomplished within 18 to 36 months, many Private-Equity
firms are pursuing sale alternatives. Private company owners and
management teams should consider the implications of a sale that
may come sooner than expected after a Private-Equity investment.
4BMFUPTUSBUFHJDCVZFS
4BMFUPPUIFSQSJWBUFFRVJUZmSN
3FDBQJUBMJ[BUJPO
0UIFS
Private Enterprise
End Notes
1 ThomsonFinancial, Buyouts, Volume 19, Issue 1.
2 Sender, Isabelle, “More Banks Turn to Private-Equity Funds”,
BusinessWeek, August 23, 2006
About Deloitte
Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms and their respective
subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organization of member firms around the world devoted to
excellence in providing professional services and advice, focused on client service through a global strategy executed
locally in nearly 150 countries. With access to the deep intellectual capital of approximately 135,000 people worldwide,
Deloitte delivers services in four professional areas, audit, tax, consulting and financial advisory services, and serves more
than one-half of the world’s largest companies, as well as large national enterprises, public institutions, locally important
clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu
Verein and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas.
As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each
other’s acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names
“Deloitte”, “Deloitte & Touche”, “Deloitte Touche Tohmatsu” or other related names.
In the United States, Deloitte & Touche USA LLP is the U.S. member firm of Deloitte Touche Tohmatsu and services are
provided by the subsidiaries of Deloitte & Touche USA LLP (Deloitte & Touche LLP, Deloitte Consulting LLP, Deloitte Financial
Advisory Services LLP, Deloitte Tax LLP, and their subsidiaries), and not by Deloitte & Touche USA LLP. The subsidiaries of the
U.S. member firm are among the nation’s leading professional services firms, providing audit, tax, consulting, and financial
advisory services through nearly 40,000 people in more than 90 cities. Known as employers of choice for innovative human
resources programs, they are dedicated to helping their clients and their people excel. For more information, please visit
the U.S. member firm’s Web site at www.deloitte.com
Copyright © 2006 Deloitte Development LLC. All rights reserved.
Member of
Deloitte Touche Tohmatsu